In equities, commodities, bonds and currencies, 2019 has all been about The Fed and Beijing reversing policy. Both have done 180° turns on their 2018 policies.

At the conclusion of the March FOMC meeting last night, Jerome Powell provided two more dovish surprises (to go with the now infamous Powell Pivot delivered at the January FOMC statement). Firstly, the median dots now indicate zero rate hikes in 2019 (down from two previously). Secondly, the pace of the balance sheet reduction (colloquially referred to as QT) will slow in May and end completely in September. Specifically, the cap on Treasury run-off will shrink from $30 billion a month to $15 billion a month in May and Fed balance sheet reduction will be halted at the end of September. These changes make it quite likely that the Fed is done with tightening for this cycle. In simple terms, the next move in US cash rates is likely down and QT is ending.

The very mild dip in the blue-shaded area in the chart below shows how far we got in unwinding the impact of quantitative easing (QE) on the Fed’s Balance Sheet. The answer is not very far!

Chart 1. Source: AIM, Bloomberg

I’m going to run through a series of high-level macroeconomic indicator charts to confirm how important these reversals of policy from the Fed and Beijing have been in the first quarter of 2019. Chart 2 shows that the global rally in equity markets (blue line, S&P 500, right hand axis) has been driven by a dovish pivot from the Fed, quickly followed by the ECB and the RBA, amongst others. In the last two months of 2018, the market moved from pricing two rate hikes of 0.50% (red line, left hand axis) to a rate cut in 2019.

Rate hike expectations for 2019 (per the futures curve) v. S&P 500

Chart 2. Source: Bloomberg

While the Fed has softened its policy stance, we have also seen China take the brakes off the shadow banking deleveraging campaign that was a big feature of 2018. This has given way to credit stimulated push to get the economy going again. In Chart 3 below, you can see that after 12 months of negative credit growth in China, the data turned positive in January and remained so in February. While most economic indicators still show that the Chinese economy is slowing (Chart 4), history would suggest an improvement in these indicators should be seen in Q2 now the credit data has turned positive.

Year-on-year change in rolling 3-month Total Social Financing (TSF) 

Chart 3

Manufacturing PMI hit heavily by the trade dispute

Chart 4. Source: AIM, Bloomberg

What does all this mean for the Aussie dollar? Who knows! The Aussie is being dragged higher by commodity prices (Chart 6, Aussie dollar in yellow, commodity price index in white)) and pulled lower by a very wide (and falling) interest rate differential with the US (Chart 5, Aussie dollar in yellow, interest rate differential in white). I don’t know which factor will win this tussle but my best guess is it stays somewhere around its current range until one of these two factors gives.

AUD v Aus/US 2-year rate differential

Chart 5

AUD vs RBA commodity price index

Chart 6

The US dollar is definitely looking a tad wobbly after last night’s move. Given this backdrop, I don’t think 2019 will be as simple as owning large cap US equities in US dollars. It may well prove better total returns come from emerging markets (China), commodities and commodity currencies.  For equities, we are back in the 2017 playbook with yield and duration. Don’t fight the Fed.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.